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The next fiscal cliff could be bigger

Huge attention is being paid to the debate over the “fiscal cliff,” the automatic tax increases and spending cuts that will take effect if Congress and the Obama administration fail to strike a budget deal by year’s end. Without such a deal, analysts say, the US economy could be headed back into recession. But even in the best case scenario, where Capitol Hill agrees on a ten-year sustainable budget, US politicians are likely to sidestep the longer-term challenge of tackling growing entitlement spending. By doing so, could they merely be building up an even bigger fiscal cliff further down the road?

The country’s long-run economic growth is also at stake, as these negotiations will decide whether the federal deficit will come down to levels that would stabilize the country’s debt -to-GDP ratio in the long-term. And according to a recent Initiative on Global Markets’ Economic Experts Panel, which polls several dozen economists weekly to get their views on public policy, most experts agreed that policymakers should focus on creating a sustainable budget beyond the ten-year window of most political budget debates.

Reforming entitlement spending is a key factor in achieving fiscal sustainability. When asked to choose between two plans that would reduce federal budget deficits by the same amount in the next decade, 91 percent of economists surveyed agreed that a plan that meaningfully reduced the long-term growth rate of Medicare and Medicaid spending would do more to make the budget deficit fiscally sustainable. None of the experts disagreed on this point. But because the exact details of an alternative plan were not specified in the survey question, the nine percent who were uncertain said their answer would depend on the details of an alternative plan.

Politicians may be able to come up with measures that would appear to fix the ten-year budget problem, but without addressing entitlement spending they’re likely just kicking the can down the road, say 71 percent of the experts surveyed. A minority of economists, 12 percent, disagreed with the proposition that politicians could easily strike a deal that reduces the deficit over the next decade, arguing that deficit reduction even over a shorter time horizon would be no easy feat.

Chicago Booth Professor Richard Thaler, who agreed on the proposition that the US stands a better chance of becoming fiscally sustainable if long-term spending on Medicare and Medicaid spending is decreased, also noted that “[the] real issue should be to abolish the ten-year [budget] window, and especially misleading attempts to disguise things via ‘temporary’ tax cuts.” The practice of putting in temporary tax provisions that are likely to be renewed makes the budget outlook appear rosier than it actually is.